Germany's top court has backed the eurozone's rescue fund, known as the European Stability Mechanism, letting financial markets breathe a sigh of relief.

The $600 billion eurozone rescue fund should have been in place by July to replace the temporary European Financial Stability Facility, but it had been held up pending this ruling.

More than 37,000 people had signed a petition asking the court to block the European Stability Mechanism and make it subject to a referendum.

That call has been rejected, but the court ruled any future increase in the size of the fund, or Germany's contribution, needs the approval of the German parliament.

The court also ruled that Germany must ensure a de-facto opt-out clause if it felt its interests were not being considered.

"The Federal Republic of Germany must make it clear that it does not want to be bound to the ESM Treaty as a whole if any reservations it might have should prove ineffectual," chief justice Andreas Vosskuhle said.

German Chancellor Angela Merkel has welcomed a ruling as good news for Europe.

"This is a good day for Germany, this is a good day for Europe," she said in a speech to parliament after the ruling.

European shares rose after the ruling and the euro has reached a four-month high against the dollar.

Meanwhile, the EU Commission wants the region to evolve into a federation of nation states and has unveiled its plans for a banking union.

But German chancellor Angela Merkel says the European Central Bank cannot be expected to oversee all banks in Europe.

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